While I don't believe the Federal Reserve quantitative easing program has created strong growth for much of the economy, there is certainly no question asset prices have improved. Since QE3 began on September 13, 2012, the stock market is up 24.97% and housing prices are up 13.29%. [ii]

Why they should wait

In spite of my personal opinion, the last time the Fed pulled their QE program, the stock market dropped sharply and the economy stalled. [iii]

Second, the economy is still dangerously close to flat-lining when it comes to inflation. [iv]

After spending over $2 trillion on bond purchases since QE 1 [v], it would fly in the face of the Fed's past experience to prematurely pull one of their last tools. Additionally, deflation is far more harmful to the economy than inflation.

Finally, the Fed does have one new tool to attempt to use. As I have written on several occasions, most inflation hawks don't appreciate the Interest Rate Paid on Excess Reserves. Basically, the Fed is paying banks interest to hold excess reserves above the mandatory requirements—creating an incentive for banks not to lend.

In the current case, the Fed is paying 25bp to banks for not taking on any lending risk. [vi] If the Fed wanted to stimulate more money velocity in our economy they could move that rate to zero, pushing banks to take more risks and actually lend, rather than collecting free money.

Specific predictions are almost always wrong, but if I were to predict a course of action the Fed might take this week, it would be some kind of adjustment to the Interest Rate Paid on Excess Reserves.

I would also suggest that both the very short and very long ends of the yield curve are most likely to face selling pressure associated with any tapering. That's why we are targeting durations around 4 years. [vii]

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